Mortgage Refinancing Basics
Always measure the costs and benefits of refinancing. This will tell if you will come out ahead. Here’s our input:
If you’re like most Americans, you have a 30-year mortgage. It’s simple. It’s stable. And it accomplishes an important task: gets you to homeownership with low, fixed payments.
But surprisingly, a 30-year mortgage isn’t always the best loan for homeowners. At times, you may only envision yourself in a property for a few years. In that case, a shorter term mortgage, such as a 5 year or 7 year mortgage, may make sense. These loan programs provide different options in terms of a possibly lower interest rate versus a traditional 30-Year fixed rate mortgage.
Adding to that, on average most Americans refinance their home mortgage every four years or so, according to the Mortgage Bankers Association. If that is the case with you, then you may be better served refinancing and adjusting your terms in order to serve your financial needs. In fact, you may see dramatic savings in doing so. This means that you may want to assess other loan options to truly demonstrate if a 30-Year fixed rate mortgage is your best option, or if other loan progams may fit your need.
Homeowners refinance in order to do one (or a few) of many things: lower the interest rate, reduce the term of the loan, lower the payment, cash out on equity in the home, consolidate other debt, or simply adjust their loan to their current financial needs.
But this doesn’t mean that refinancing doesn’t have a cost. In the short-term, refinancing may have some costs that may need to be recouped before a sound decision is made. Allow us to help you effectively make a decision based on the economics of your current loan and any new potential loan.
Here are some reasons to consider mortgage refinancing:
· To obtain a lower fixed rate. If you took out a mortgage years ago, you know that interest rates have dropped since. Refinancing may certainly lower your payments. Sometimes, payments can drop dramatically. For example, a $200,000 mortgage with a 30-year term and a rate of 6 percent carries a monthly payment of $1,200. That same mortgage with a 6 percent will have a payment of $890 a month. We call that savings, savings, and more savings! As you can see, refinancing will reduce monthly payments by $310. This equates to an annual saving of $3,720!
· To convert a fixed rate mortgage or an adjustable rate mortgage. Fixed rate mortgages provide stability, but sometimes at a higher rate and cost. Adjustable-rate mortgages (ARMs) sometimes less stability but with the trade-off being a lower interest rate in the initial years of the loan. For some homeowners, fixed rate mortgages make sense. They are safe, stable, and easy to predict. Payments don’t fluctuate.
Adjustable rate mortgages, however, provide less stability. They can be locked for 5 years, 7 years, or 10 years, meaning the fixed period of the loan will be 5, 7, or 10 years but the mortgage payments and rate will adjust accordingly after that. These loans often provide a lower start rate in the initial 5, 7, or 10 years to the homeowner. Exploring options of an ARM versus a fixed rate mortgage may be worthwhile if a homeowner has shorter term plans with the mortgage, the home, or is comfortable with payments adjusting once the interest rate for the ARM adjusts.
· To create home equity quicker! If you’ve recently received a raise in your salary, or have had a general change in your financial circumstances, that now allow you to pay moretowards your mortgage each month, then refinancing may make sense. You may be able to refinance from a 30 year term, for example, to a 15 year term. Thus, your payment would increase but you would also shed 15 years from the total amortization and term of the loan. This means less interest paid to the lender and means more savings in your pocket. More savings in your pocket and quicker home equity build-up is the outcome of this scenario.
· To decrease your monthly payments. Refinancing your mortgage and extending the term may decrease your monthly payment. This strategy may be good for you if the decrease in monthly payments will help improve your financial situation. For example, you may want to refinance from a 15 year term to a 30 year term, which would undoubtedly reduce your mortgage payment each month. Although you would stretch the loan's duration and repayment term an additional 15 years, the immediate cost savings would be significant.
· To turn equity sitting in your home into productive capital/cash. You may have paid your mortgage down over months and years of repayment. As a result, you now have a significant amount of equity built up and sitting in your home. Or, you may have experienced a dramatic rise in the value of your home due to price appreciation. Either way, you now have money and it’s sitting, parked in your home. You may want to take out a new mortgage with a larger loan amount, allowing you to extract equity in the form of cash.
We always suggest using this equity cash productively; paying down other debt or expenses with higher rates of interest may be worthwhile. Sound investments in other assets may also be worthwhile; for example, if you use cash out from equity to purchase an investment property, this may be a good economic decision. With a larger loan amount, however, using your home equity wisely is crucial to your financial success.
This process generally is known as cash-out refinancing or refinancing to extract equity. One of the distinct advantages is that the rate will be markedly lower than other forms of loans; this is because your home serves as the collateral, and which lender wouldn’t feel safe using your home as collateral during the repayment of a loan?
So by now, you may be asking if mortgage refinancing is right for you
We will always ask a few questions ourselves, while assessing your decision to refinance:
How long do you plan on being in your home? If you plan on selling your home in a few years, you may never recoup the cost of refinancing. If you have longer term goals with the home, then recouping the costs shouldn’t be an issue.
Do you have a prepayment penalty? If you do, then that cost must be factored into the cost of refinancing. Recouping the prepayment must be a real potential when assessing overall costs.
What are the costs of the new mortgage? With refinancing, there is always a cost. Whether you only pay an appraisal fee, or third-party fees like title and escrow, or fees such as origination charges, there are always fees. When you take out a new mortgage, you must assess the overall costs of the loan.
Is there a true difference in the borrowing costs? Look the at the APR. The annual percentage rate factors in not only the nominal rate, but also your costs over the duration of the loan. The APR is a direct function of the amount paid over the term of the loan. So analyzing that will provide a great deal of insight as to the benefits of refinancing (or lack thereof).
Will your tax savings adjust? Mortgage interest can be claimed on your tax returns as a deduction. So while you may lower your rate and payment/interest, you may lose some tax incentives you otherwise would have enjoyed. You may want to consult a tax accountant or whoever prepares your tax returns.
For a free analysis about potential benefits of refinancing, use our Refinancing Calculator. Or simply contact us today. You can quickly apply with MortgageLoan Corp.
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